Earnings-based borrowing constraints & corporate investments in 2007–2009 financial crisis

Abstract

Recent work on the debt composition of non-financial firms finds that most of the large firms’ debt is cash flow-based with earnings-based borrowing constraints (EBCs), limiting the maximum debt relative to firms’ EBITDA. During the 2007–2009 crisis, EBCs tightened in the leveraged loan market. Consistent with the reduction in the supply of credit, I find that investments and debt issues of firms with binding EBCs reduce significantly compared to control firms. Furthermore, firms with binding EBCs cut their share repurchases and total payout during the crisis. In the cross-section, the reduction in investments and total payout is larger in the subsample of firms whose marginal borrowings are more likely to come from cash flow-based debt.